Design Principles For
Impact-linked Finance
Background
The practice and concept of Impact-Linked Finance was defined by Roots of Impact, the Boston Consulting Group (BCG), and BCG Henderson Institute in 2019 with the report Accelerating Impact-Linked Finance. The Design Principles for Impact-Linked Finance were published for the first time as part of this report.
The goal of these Principles is to support the effective use of Impact-Linked Finance and guide practitioners in its application. While the Principles represent a benchmark for the most effective use of Impact-Linked Finance, not all Principles can be applied to the same degree in each individual transaction; rather, the Principles should be considered and balanced as a whole.
The initial Principles successfully guided the first ILF initiatives by pioneering practitioners. They were subsequently updated in 2023 to accommodate a broader range of stakeholders, objectives, and approaches, and, with the launch of the Impact-Linked Finance Collaborative, the Principles are currently undergoing another round of refinement to reflect the advances in the growing field of ILF.
Detailed Principles
and Guidance for implementation
1. CONSIDER IMPACT AS A MEASURE OF PERFORMANCE
Rewards need to be directed to the actor who is most central in the value creation process and/or has the most decision-making power where/what impact is being created. If several relevant stakeholders are involved, it can be considered to split among them appropriately.
2. ALIGN INCENTIVES FOR ALL STAKEHOLDERS
Impact-Linked Finance solutions must equitably balance risks and returns to provide aligned incentives for the major stakeholders in terms of social, environmental, and economic value. Seek alignment of incentives with the enterprise’s business strategy.
3. PROVIDE INCENTIVES TO THE VALUE CREATOR
Rewards need to be directed to the actor who is most central in the value creation process and/or has the most decision-making power where/what impact is being created. If several relevant stakeholders are involved, it can be considered to split among them appropriately.
4. FOCUS ON SIMPLICITY AND TRANSPARENCY
Avoid complicated models. Incentives must be easy to be understood by all stakeholders, with straight-forward and transparent metrics, rewards, and processes. A standardized framework for impact incentives (impact matrix) can be effective in creating transparency and achieving efficiency gains for recurring transactions in specific sectors.
When using standardized frameworks, the incentive scheme for an individual enterprise (with selection of most relevant metrics, adequate weighting, and pricing), needs to be tailored to the specific context of the enterprise. The potential for additionality and alignment with the business strategy should be considered. Use benchmark metrics, when possible, otherwise customization is needed.
5. ENSURE IMPACT ADDITIONALITY
Incentives and rewards should be provided for additional outcomes that would not have happened anyway. If applicable, other capital flows and their anticipated effects must be considered when determining the impact additionality, including effects of investments catalyzed by the incentives. During the term of a transaction, adjustments to metrics or incentive schedules may be made as conditions change (see Principle 1). These adjustments should ensure or increase impact additionality.
6. ENABLE FINANCIAL ADDITIONALITY (LEVERAGE)
The transaction should enable the enterprise to raise investment at the same time or at a later stage. Either incentives are directly linked to additional investment, or the terms are structured to facilitate future capital rounds. In the first case, higher leverage is not always better. Instead, leverage has to be appropriate for the context, and financial resources are a means to create impact additionality.
7. ADAPT PRICING TO SPECIFIC CONTEXT
The pricing of rewards should be based on objective criteria, but the incentive levels set should maintain flexibility to fit to a given context. Depending on the context, price points for similar outcomes can differ significantly from transaction to transaction.
8. DESIGN INFORMED AND FAIR INCENTIVES
The level of incentives should be high enough to attract interest from enterprises but also represent the best value possible for the funder. Pricing should consider potential synergies with business operations and be determined after an analysis of the enterprise's individual potential.
9. FOCUS ON OUTCOMES VS. OUTPUTS
Wherever feasible, incentives should be based on outcomes or robust proxies for outcomes, not on inputs or outputs. Impact metrics and requirements for impact measurement and verification should be in reasonable relation to the size of the transaction, the enterprise phase, and the available budgets. Consider designing transactions with evolving metrics: For example, it may make sense to start with evidence-backed outputs that are then replaced by strong proxies and outcomes indicators over time. Or rigor can be increased over the duration of one or more transactions (including incentives for the enterprise to meet higher requirements). Evolving metrics and incentives can help organizations on their journeys to specify and optimize their impact over time.
- katie.naeve@ilfcollaborative.org
- +1 (515) 213 1679
Driving a new era in finance where capital is aligned with impact to create meaningful, measurable change across communities worldwide.
